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Better Buy: Western Digital Corporation vs. Texas Instruments

Should investors buy the maker of hard-disk drives or the maker of electric toothbrush chips?

Western Digital(NASDAQ:WDC) is a leading manufacturer of hard-disk drives (HDDs) and flash-based storage products. Its ownership of SanDisk gives Western the No. 3 market share spot in NAND flash memory, which is used to make solid-state drives (SSDs).

On the other side, Texas Instruments(NASDAQ:TXN) makes analog and embedded processors for everything from calculators and electric toothbrushes to infotainment systems in cars. These are chips that are designed to do very specific things like control temperature or convert streams of digital data for other chips to process.

Western Digital's share price is down 33% over the last year as NAND flash memory prices are plunging. Investors are also concerned that selling prices for disk drives may be peaking, as well.

Texas Instruments shares are up 25% over the last year as the chip maker has posted solid results. Investors are optimistic about the company's future opportunity to apply its chips to various industries, including aerospace, transportation, medical, and wireless infrastructure, just to name a few.

We'll compare Western and TI on recent performance and where they stand competitively to determine which is the better buy for investors today.

Trends impacting Western Digital and Texas Instruments

Western has big growth opportunities in artificial intelligence, machine learning, and Big Data applications. Every year, more and more data is being collected from mobile devices, cloud computing, and the Internet of Things, which is expected to grow demand for storage capacity over time. Lately, Western has seen strong demand from data centers as organizations are buying high-capacity disk drives, which are cheaper than flash storage and offer much higher storage capacity than SSD.

The drawback for Western is that the industry is very cyclical. A strong pricing environment can vanish as competitors rush to meet demand, which can create oversupply and send selling prices down. Lately, selling prices for flash-based memory products have been falling as a result of over-investment throughout the industry as the transition from 2D flash to 3D flash technology is maturing.

IMAGE SOURCE: GETTY IMAGES.

Meanwhile, TI is starting to hit its stride. The stock is up 128% over the last three years as investments made in the industrial and automotive markets have paid off in a big way. Revenue accelerated last year to 12% as these markets now make up 54% of total revenue, up from 42% in 2013.

There are expected to be an increasing number of uses for TI's chips over time as cars become more computerized. Also, products for industrial and automotive applications are less capital-intensive and, therefore, provide the potential for improving margins and profitability over time. That's why investors continue to buy shares of Texas Instruments.

However, analysts expect revenue to be roughly flat next year, while they expect earnings to decline 20% to $11.72. Analysts have recently downgraded the stock, citing concerns that we may be seeing a peak in HDD selling prices, which have benefited Western's top-line growth recently.

Over the next five years, analysts expect Western to grow earnings 5.6% per year. Western has been able to grow earnings with cost reductions and share repurchases, but analysts are concerned that most of the easy cost-cutting has already been made, and that the company will have to rely more on top-line growth going forward, which may not be much if Western finds itself in a prolonged downturn in pricing.

On the other side, TI is expected to continue its recent solid results going forward. The chip maker reported 9% year-over-year growth in the second quarter, as demand continues to be strong in the automotive and industrial markets. Earnings per share surged 36% year over year, reflecting cost discipline and share repurchases. Analysts expect TI to grow revenue 7.7% this year, while earnings are expected to grow 30%.

The growth in the automotive market will only widen TI's competitive moat over time. TI has been seeing an increasing amount of content per car over time, which helps lengthen the revenue cycle. This strengthens TI's competitive position in the industry as customers tend to stick with one supplier over another for the long haul.

Over the next five years, analysts expect earnings to grow 14.4% annually. TI is currently transitioning its business from 200mm chips to 300mm, which are 40% cheaper to make. As that transition unfolds, TI should see its gross margin expand. Those gains combined with other cost efficiencies and share repurchases should propel earnings growth at a double-digit rate going forward.

Which is the better buy?

Western's forward P/E of 5.0 might be tempting for value-hunting investors. Additionally, the stock offers a generous dividend yield of 3.51%, and Western has the potential to increase its payout significantly over time given it only distributed 18% of its free cash flow in dividends last year.

Still, investors should be cautious, here. Western may be at the peak of a cycle, as noted by recent analyst downgrades and management's guidance for pricing pressure with NAND flash memory in the short term. The HDD market has been in a decline for several years, with current strong demand from data centers as its temporary saving grace.

However, at some point, the scales will tip in favor of SSD, which is a more competitive market than HDD. Major tech leaders like Intel and Samsung Electronics are vying for position in the flash market. It's uncertain where that will leave Western competitively over the long term.

Meanwhile, there's really nothing stopping TI right now. The chip maker is expected to maintain solid revenue growth going forward. Things that we never thought would use advanced technology are starting to utilize TI's chips more and more: appliances, rail transport, energy, building and factory automation, among a host of other areas.

Even though it's more expensive at a forward P/E ratio of 18, I believe Texas Instruments is the better buy.